Beware ‘Audit the Fed’

Federal Reserve Chairman Ben Bernanke at the Treasury Department in Washington, D.C., July 18, 2012 The new bill subjects the Fed to election-driven considerations.

Nobody really likes the Federal Reserve. Some conservative economists think the Fed does too much, liberals think it doesn’t do enough, and many of the rest of us see it as a bunch of egghead academics teaming up with alpha-male Wall Street bankers. It’s entirely understandable that Congress would want to increase its oversight of the Fed’s operations, but the “Audit the Fed” bill recently passed by the House is the wrong way to do it.

Representative Ron Paul (R., Texas) has been on the Fed’s case for practically the entire course of his long political career. In his heart, Paul wants to (as the title of his book has it) “end the Fed,” but he has, possibly for the first time in his political life, compromised. Now, all he wants to do to the Fed is audit it.

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#ad#The Fed is a creature of statute, and Congress has both the authority to audit it and the responsibility to oversee it. A fiscal audit of the Fed is not in itself objectionable — the problem is having Congress insert itself into the Fed’s internal monetary-policy deliberations, which are for very good reason insulated from the political process.

This is not a question of the Fed’s fiscal probity: The Government Accountability Office (GAO) already audits the Fed’s financial statements. What Paul and his House colleagues are seeking is for the comptroller general to audit the Fed and then return a “detailed description” of its operations to Congress, along with “recommendations for legislative or administrative action.” This would undermine the monetary-policy independence that is the Fed’s main reason for existence.

In congressional testimony, Fed chairman Ben Bernanke described the effect of the bill: “What the Audit the Fed bill would do would be to eliminate the exemption for monetary-policy deliberations and decisions from the GAO audit. So, in effect, what it would do is allow Congress, for example, to ask the GAO to audit a decision taken by the Fed about interest rates.” Bernanke is correct when he argues that this would “create a political influence . . . on the Federal Reserve’s policy decisions.”

The idea of having Congress take a stronger position on monetary policy might be appealing to conservatives who trust Paul Ryan or Ron Paul more than they trust Ben Bernanke, but there are no permanent congressional majorities. It is not difficult to imagine the mess they would make should the Barney Franks, Chris Dodds, and Maxine Waterses of the world be given a whip hand over monetary policy. Short-term, election-driven political considerations have a pronounced tendency to distort economic policy: Consider that the millennial housing bubble was in no small part a creation of public policy.

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The temptation for Congress to use monetary policy to influence electoral outcomes would almost certainly prove too great to resist. A Congress controlled by one party facing an incumbent president from the other party would have powerful incentives to constrict the money supply and slow growth, perhaps even causing a recession, in the year before the election. Likewise, incumbents facing an elevated unemployment rate — say, above 8 percent going into “the most important election in our history” — would have powerful incentives to take radical and irresponsible steps toward short-term monetary stimulus. It is precisely this political temptation that has led to the creation of independent central banks to implement monetary policy.

While the current crop of Republicans is steadfast on the issue of inflation, there is no reason to assume that this commitment will last forever. For most of American history, populist forces have called for higher inflation to reduce the real costs of paying back loans. During the free-silver movement of the late 19th century, American farmers and their Democratic representatives in Congress called for a debased dollar backed by gold and silver, as opposed to gold alone. At the time, deflation was ravaging the economy, hitting indebted farmers especially hard. A 21st-century middle class suffering from deflation in housing prices and a raft of upside-down mortgages has essentially the same incentives. When inflation is lower than had been anticipated, it makes it harder for people to pay down their credit-card debts, their mortgages, their student loans, etc. Populists would call on the Fed to print more money, and congressional incumbents would have good reason to go along with that.

Before we give Congress more authority over monetary policy, let’s consider how it’s doing with fiscal policy: The federal government has annual deficits running in excess of a trillion dollars, a $16 trillion national debt, endless partisan fights over the tax code, the highest corporate tax rate in the developed world, special-interest loopholes to help favored businesses at the expense of everybody else — none of which suggests that Congress is likely to do a better job with monetary policy than the Fed. And that’s with a Republican House.

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Instead of expanding its own powers, Congress should simply limit the Fed by statute. Congress could pass a law requiring the Fed to follow the Taylor Rule, which was first introduced by John Taylor of the Hoover Institution. Although an imperfect guide for interest rates, the Taylor Rule would limit the Fed’s ability to cause problems. Another possibility is applying Milton Friedman’s theory that the money supply should be increased by a constant rate every year, without regard to economic conditions. Both proposals would limit the Fed without the problem of Congress’s directing day-to-day monetary policy.

Ron Paul’s heart is in the right place, but the vast majority of the other 326 House members who voted to audit the Fed do not share his commitment to limited government and Austrian economics. A monetary policy brought to you by the same people who gave us a $16 trillion debt would mean only one thing: trouble.

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